Economics  -  Externalities and Public Goods  - Chapter 5.docx

Economics - Externalities and Public Goods - Chapter 5 Summary • There is strong evidence that using the mechanisms of a market economy is improving the life of billions in terms of income, access to goods and services and general welfare. • This is in line with the theory: markets have a built-in t...

Economics - Externalities and Public Goods - Chapter 5 Summary • There is strong evidence that using the mechanisms of a market economy is improving the life of billions in terms of income, access to goods and services and general welfare. • This is in line with the theory: markets have a built-in tendency towards efficient resource allocation. • However: it seems that sometimes the market leads to obviously inefficient situations. -> Why? and how can this be fixed? Learning goals Types of externalities; Positive Externality: A positive externality occurs when an activity or action generates benefits for third parties who are not directly involved. For example, education benefits society as a whole by producing an informed and skilled workforce. Negative Externality: A negative externality arises when an activity imposes costs or harms on third parties who are not involved in the transaction. Pollution from a factory, for instance, imposes health and environmental costs on the surrounding community. How to reach the social optimum? Social Control: Implementing regulations to address environmental issues, such as setting limits on industrial emissions or enforcing waste management practices, to protect public health and preserve natural resources. Environmental Standards: Establishing standards for energy efficiency in appliances or vehicles to reduce greenhouse gas emissions and promote sustainable consumption patterns. Emission Tax: Imposing a tax on carbon emissions, where companies pay a fee based on the amount of greenhouse gases they release. The tax incentivizes companies to reduce emissions and transition to cleaner technologies. Market Mechanisms (Coase Theorem): For instance, in the case of pollution, allowing affected parties to negotiate and reach agreements on emission reductions or compensation without government intervention. This approach can encourage more efficient outcomes by aligning the costs and benefits of pollution reduction Environmental standards • catalyser in cars • Diesel exhaust fluid DEF (f.e. AdBlue) • Governmental checks of private fuel-based heating systems • Prohibition of electric heating systems in houses • Noise standards for machines, air planes, cars, motorbikes etc. • Prohibition to wash cars on regular ground Standards vs Piguvian tax - addressing negative externalities. Standards set specific regulations, while Pigouvian taxes impose fees on activities causing externalities. Standards provide direct control, while Pigouvian taxes create economic incentives. The choice depends on factors such as feasibility and preferences. Both approaches may be used together for optimal results. - Emission tax - Market (Coase theorem) - Direct internalization of externalities - Emission certificates one compensates the others cost and the govt has to regulate who owns what (farmer vs. fisher = who owns the water?) • Coase theorem, its implication and limitation; The Coase Theorem is an economic theory. The theorem states that in the absence of transaction costs, the allocation of resources in a market will be efficient, regardless of how property rights are assigned, as long as property rights are well-defined and transferable. In other words, the Coase Theorem suggests that as long as people can freely negotiate and trade with each other, they will always find the most efficient way to use resources, regardless of who owns those resources. This is because in a free market, people will be incentivized to make mutually beneficial trades that improve their overall welfare. However, the Coase Theorem also recognizes that in real-world situations, transaction costs can interfere with the efficient allocation of resources. Transaction costs include things like the cost of searching for potential trading partners, the cost of negotiating and enforcing agreements, and the cost of gathering information about the quality of goods and services. When transaction costs are present, the allocation of resources may not be efficient, even if property rights are well-defined and transferable. Understand the circumstances in which an intervention into the market is needed to create efficiency; - Low transaction costs When transaction costs, including communication and coordination, are low, market participants can interact easily and efficiently. In such cases, market forces alone can achieve optimal outcomes without significant government intervention. - Emission certificates In the context of environmental externalities like pollution, interventions such as emission certificates can help create efficiency. Governments can reduce transaction costs by setting clear rules and regulations, specifying emission limits, and establishing a system for trading emission certificates through cap-and-trade mechanisms. Know the main intervention tools and their effects; Positive Externalities When markets do not efficiently provide positive effects on the society - education and research - vaccination - foest and undeveloped land Understand the definition of public goods